Higher Taxes: Will The Republicans Cry Wolf Again?

Yesterday, President Obama issued his first detailed budget. Among its most controversial proposals is a significant increase in taxes, especially on those with upper incomes. Obama also proposes a cap-and-trade system to reduce pollution that is in essence a broad-based energy tax.

Republicans will undoubtedly make extravagant claims about the detrimental economic effect of these higher taxes. When one hears these claims, however, it is worth remembering that they said the same things in years past and none of their dire predictions came to pass.

According to a recent Treasury Department study, Ronald Reagan proposed the largest peacetime tax increase in American history as part of a budget deal to get the federal deficit under control. The Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982 was signed into law on Sept. 3, and most of its provisions took effect on Jan. 1, 1983.

During debate on TEFRA, many conservatives predicted economic disaster. They argued that raising taxes in the midst of a severe recession was exactly the wrong thing to do. "Every school child knows you don't raise taxes in a recession unless you want to make it worse," The Wall Street Journal's editorial page warned. Said Rep. Newt Gingrich, "I think it will make the economy sicker." The Chamber of Commerce of the U.S. said it had "no doubt that it will curb the economic recovery everyone wants."

Looking at the data, however, it is very hard to see any evidence that TEFRA had a negative effect on growth. Indeed, one could easily make a case that its enactment stimulated growth. As one can see, the economy's growth rates after TEFRA took effect were among the fastest in history.

Year/Quarter

Real GDP Growth

1982 III

-1.5%

1982 IV

0.4%

1983 I

5.0%

1983 II

9.3%

1983 III

8.1%

1983 IV

8.4%

1984 I

8.1%

1984 II

7.1%

Source: Bureau of Economic Analysis

The unemployment rate also peaked just before TEFRA took effect at 10.8% in December 1982. Throughout 1983, it fell steadily to 8.3% by year's end. The unemployment rate continue to fall through 1984, reaching 7.3% by December.

In 1993, Bill Clinton proposed another major tax increase. Perhaps because it was initiated by a Democrat, conservatives were even more convinced that it would bring about economic disaster. In an Aug. 3, 1993, media fact sheet, John Goodman of the National Center for Policy Analysis predicted the following results from the higher taxes: Capital formation would be reduced by $1.76 trillion through 1998, 1.34 million fewer jobs would be created and the real GDP growth rate would be 0.4% lower than it otherwise would have been.

An examination of the data, however, shows that this forecast was totally wrong in every respect. The following table shows what happened after the 1993 tax increase was signed into law on Aug. 10.

Year/Quarter

Real GDP Growth

Gross Private Domestic Investment

1993 III

2.1%

0.0%

1993 IV

5.5%

22.3%

1994 I

4.1%

18.3%

1994 II

5.3%

25.5%

1994 III

2.3%

-6.9%

1994 IV

4.8%

19.9%

Source: Bureau of Economic Analysis

The unemployment rate was at 6.8% when the law was signed and fell steadily thereafter, reaching 5.5% by the end of 1994. By Clinton's second term, the economy was booming to such an extent that the federal government began running large budget surpluses.

Of course, past experience doesn't necessarily tell us what will happen in the future. Maybe this time, the conservative scaremongers will be right, and higher taxes will abort recovery and bring on a sharp economic setback such as happened in 1937.

But even if conservatives were willing to concede that Obama's proposed tax increases won't deepen or lengthen the recession, they would still oppose higher taxes because they cling blindly to the starve-the-beast theory, which says that if revenues are not allowed to rise, then pressure to reduce the deficit will be channeled into spending cuts.

The problem with this theory is that there is not one iota of evidence that starving the beast works. Under George W. Bush, federal revenues fell from 20.9% of GDP in 2000 to 17.7% in 2008, but spending rose from 18.4% of GDP to 20.9% over the same period.

Bill Niskanen of the libertarian Cato Institute thinks the starve-the-beast theory has actually had a perverse effect on spending. Because Republicans convinced themselves that the only thing they needed to do to restrain the growth of government was cut taxes, it caused them to become "casual about the sustained political discipline necessary to control federal spending."

Republicans have also developed a certain mythology about Ronald Reagan's administration. They think he held the line on taxes and that this forced Democrats to accept spending cuts. The evidence, however, could more easily be interpreted in the opposite direction: Democrats forced Reagan to raise taxes in return for insignificant spending cuts. He himself later lamented that none of the cuts in appropriations he had been promised by congressional Democrats were ever implemented.

As the table below demonstrates, Reagan signed into law major tax increases every year of his presidency after the first. By the end of his presidency, he took back half of the 1981 tax cut in the form of higher taxes. And it should also be noted that when confronted with a crisis in Social Security in 1983, Reagan endorsed a rescue plan drafted by Alan Greenspan that consisted almost entirely of higher taxes.

Legislated Tax Changes by Ronald Reagan as of 1988

Tax Cuts

Billions of Dollars

Economic Recovery Tax Act of 1981

-264.4

Interest and Dividends Tax Compliance Act of 1983

-1.8

Federal Employees' Retirement System Act of 1986

-0.2

Tax Reform Act of 1986

-8.9

Total Cumulative Tax Cuts

-275.3

Tax Increases

Billions of Dollars

Tax Equity and Fiscal Responsibility Act of 1982

+57.3

Highway Revenue Act of 1982

+4.9

Social Security Amendments of 1983

+24.6

Railroad Retirement Revenue Act of 1983

+1.2

Deficit Reduction Act of 1984

+25.4

Consolidated Omnibus Budget Reconciliation Act of 1985

+2.9

Omnibus Budget Reconciliation Act of 1985

+2.4

Superfund Amendments and Reauthorization Act of 1986

+0.6

Continuing Resolution for 1987

+2.8

Omnibus Budget Reconciliation Act of 1987

+8.6

Continuing Resolution for 1988

+2.0

Total Cumulative Tax Increases

+132.7

Source: Office of Management and Budget, FY1990 budget

Many of the same Republicans who today complain about Obama's spending voted for every pork-barrel project proposed by any Republican during the years they controlled Congress, as well as voting for a vast expansion of Medicare spending in 2003 when the program was already bankrupt.

Among those voting to further bankrupt Medicare were such self-proclaimed protectors of the public purse as House Republican Leader John Boehner, House Republican Whip Eric Cantor and House Budget Committee Ranking Republican Paul Ryan. When they complain about Obama's spending, they should be reminded that their vote to expand Medicare added $17.2 trillion to the nation's long-term indebtedness, according to the latest report by Medicare's trustees (Table III.C23).

None of this is meant to defend Obama's tax increases. They must be judged on their own merits and in terms of the potential benefits of the programs they would fund. But when Republicans claim that higher taxes will destroy the economy, they should be reminded that they made the same argument in 1982 and 1993 and that the actual economic results were the opposite of what they predicted. And when they denounce Obama's health plan for expanding the size of government, they should be asked how they voted on the Medicare bill in 2003.